Outsourcing or sub-contracting of infrastructure projects will attract a service tax, the finance ministry has said, a move likely to raise project costs.

Service tax, which is 10%, will have to be paid even on exempted sectors such as construction of dams, tunnels, roads and bridges.

"Sub-contractor is essentially a taxable service provider. The fact that services provided by such sub-contractors are used by the main service provider for completion of his work, does not in any way alter the fact of provision of taxable service by the sub-contractor," the Central Board of Excise and Customs, the apex body for indirect taxes, has said.

The move is likely to raise costs for most large infrastructure companies - such as Larsen & Toubro and Sobha Developers - that are into construction of dams, tunnels, roads and bridges and sub-contract part of the job.

Experts say these companies will have to absorb the cost escalation or pass it on to the consumers.

"The contractors would need to factor this in their project costs", said KPMG executive director Pratik Jain.

The government has exempted works contract service in construction of dams, tunnels, road and bridges from service tax, but not sub-contractors, even if they provide input to work contract service providers.

For work contracts, however, there is an optional composite levy rate of 4 %. Works contract service providers engage sub-contractors for services of architects, consulting engineers, design, erection commissioning or installation, and management and maintenance, among others.

Industry had sought exemption for sub-contractors, saying the services provided by them were 'in relation to' the exempted works contract service. "The fact that a given taxable service is intended for use as an input service by another service provider does not alter the taxability of the service provided," the Central Board of Excise and Customs said in a circular.

Experts say this clarification nullifies benefit of exemption. "The intention of the exemption is not to tax the works contract services used for specific activities, if tax is charged on sub-contracted services, the benefit of the exemption is essentially nullified," said Bipin Sapra, partner, Ernst & Young.